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is a type of stock used frequently by venture capital investors. The stock's preferred status gives the investor a preference in the event of a company liquidation or sale. In growing companies, this preference usually entitles the investor to receive back its investment, and an agreed upon return, before other investors receive any proceeds from a liquidation or qualifying sale. A typical convertible preferred stock used by venture capitalist investors also entitles the investor to convert his shares into common stock at a predetermined formula and to vote the preferred stock on issues presented for shareholder vote. The voting rights conferred on the convertible preferred stock often include the right to elect one or more directors to the company’s board of directors and to approve certain defined major decisions. Common "major decisions" include the issuance of additional shares of stock to others, the sale or merger of the business, the creation of new stock with preferential rights and the change of the company’s core business activity. The formula used to convert the convertible preferred stock into shares of common stock typically includes an adjustment mechanism, called an antidilution provision, that protects the investor against dilution in his percentage ownership caused by sales of cheaper stock to later investors. The nature and extent of the protection afforded can be very important to the holders of the company’s common stock. The more protected the holder of convertible preferred stock is from dilution the more dilution the common stockholders are likely to suffer. Some convertible preferred stocks also permit the investor to require the company to redeem the preferred stock after a predetermined time for an amount that gives the investor a modest profit. Some entitle the company to force to redemption or conversion to common stock after a period of years. See: Antidilution Provisions, Calls, Convertible Debentures, Convertible Securities, Dilution (Percentage), Dilution (Value), Preferred Stock Umbrellas, Puts, Ratchets, Structure, Subordinated Convertible Debentures, Venture Capital Deal Structures, Weighted Average Antidilution. |
